Fed Loosens Reins on Private Funds Buying Into Banks

Rob Quinn, Wall Street Journal
September 23, 2008

The Fed has loosened the rules that curtailed private investments in banks, the Wall Street Journal reports. The move may inject more cash into the financial system—if private equity chooses to invest—but will raise fears of profit-hungry investors snapping up stakes in banks to make quick cash with risky loans.

Under the new rules, an investor can take a stake of up to 33% in a bank without being deemed a controlling investor—a designation that would open up the investor to direct scrutiny from the Fed. Some experts say the relaxed rules don't mark a complete turnaround for the Fed, but may encourage investors to help shore up a banking industry that hasn't had any big injections of investor cash since April.

Fed Loosens Rules for Control of Bank Holding Companies

DealBook
September 22, 2008

The Federal Reserve late Monday revised some of its rules governing bank holding companies, loosening some ownership restrictions as Goldman Sachs and Morgan Stanley seek to shed their status as “investment banks.”

Among the biggest changes by the Fed, as outlined in a policy statement on its Web site, is permission for private equity firms to take one seat on boards of bank holding companies in which they have an investment, and in some cases two. Private equity firms can also expand their voting interest to 15 percent from 9.99 percent and hold a total of 33 percent economic interest in the bank holding company, up from 25 percent.

The changes come amid a big shakeup in the banking industry. Several banks have already collapsed this year, and Washington Mutual, the nation’s largest thrift, is seeking to sell itself before it may be thrust into receivership. WaMu has already received a $7 billion investment from a consortium led by TPG.

And late Sunday night, the Fed allowed Goldman and Morgan to become bank holding companies, abandoning their statuses as investment banks to become direct competitors to JPMorgan Chase, Citigroup, Bank of America and the like.

The Fed’s primary goal has been to limit the control that a private investment firm could exercise over a bank holding company, an issue that has gained prominence because of WaMu’s troubles and the changeover of Morgan, which already sold a 9.9 percent stake in itself to the China Investment Corporation.

Go to Federal Reserve Statement »

§ 225.144 Policy statement on equity investments in banks and bank holding companies
(a) Introduction and guiding principles. For many years, bank holding
companies, nonbank financial companies, private equity funds, and other firms
have made minority equity investments in banks and bank holding companies.
These investments often raise a common set of questions about the extent to which
the investment would cause the investor to become subject to supervision,
regulation, and the other requirements applicable to bank holding companies under
the Bank Holding Company Act (“BHC Act” or the “Act”) and the Board’s
Regulation Y. In general, the BHC Act applies to any company that controls a
bank or bank holding company (“banking organization”). The BHC Act provides
that a company has control over a banking organization if (i) the company directly
or indirectly or acting through one or more other persons owns, controls, or has
power to vote 25 percent or more of any class of voting securities of the banking
organization; (ii) the company controls in any manner the election of a majority of
the directors or trustees of the banking organization; or (iii) the Board determines,
after notice and opportunity for hearing, that the company directly or indirectly
exercises a controlling influence over the management or policies of the banking
organization. Minority equity investments in banking organizations are designed not to trigger either of the first two prongs of the definition of control. These investments often raise questions, however, regarding whether the investor will be able to exercise a controlling influence over the management or policies of a banking organization.

The Fed Wants More Private Equity Investments

By Tom Taulli, RSS feed
September 23, 2008

While the government plans to write some big checks to stabilize the financial system, it's probably not enough. There are various sources of capital that can help out, such as private equity.

But there has been a big stumbling block: regulation. That is, if a private equity operator takes a 10% equity stake in a bank, the firm may be considered "controlling," which would trigger some onerous compliance requirements and may mean becoming a bank holding company.

Well, according to the Wall Street Journal [a paid publication], the Federal Reserve is now going to loosen things up. The trigger point is now a 33% equity stake (up to 15% can be voting stock). Something else: a private equity firm can even have as many as two board seats.

No doubt, this is a big deal for private equity firms. And it's a nice option for ailing banks.

According to Bloomberg, private equity firms raised $324.4 billion in the first half of this year, and as should be no surprise, the hot area is distressed investing. In other words, the private equity folks have something to be happy about.

Fed Eases Private-Equity Rule

American Banker
September 23, 2008

In what is emerging as a multipronged effort to reinvigorate the financial sector, the Federal Reserve Board said Monday that it would loosen rules that limit private-equity investments in banking companies.

The 15-page policy statement could ease struggling financial institutions' access to new sources of capital.

Reversing previous policies, the Fed said a private-equity investor could hold a single seat on a bank's board without wielding too much control over the institution.

"Although having a representative on the board of the banking organization enhances the influence of a minority investor, the Board's experience has shown that, in the absence of other indicia of control, it would be difficult for a minority investor with a single board seat to have a controlling influence over the management or policies of the banking organization," the Fed said in its policy statement.

While maintaining its interpretation of the Bank Holding Company Act as barring an investor from holding more than 25% of voting stock without registering as a bank holding company, the Fed said the law "does not impose an express limit" on the ownership of nonvoting shares.

Now, the Fed will allow private equity investors to hold up to a third of a bank's total shares. But in an effort to minimize the holding's influence, the Fed said private equity investors could not hold more than 15% of voting shares. The remaining 18% must be nonvoting.

"In particular, the Board would not expect that a minority investor would have a controlling influence over a banking organization if the investor owns a combination of voting shares and nonvoting shares that, when aggregated, represents less than one-third of the total equity of the organization (and less than one-third of any class of voting securities, assuming conversion of all convertible nonvoting shares held by the investor) and does not allow the investor to own, hold, or vote 15% or more of any class of voting securities of the organization," according to the policy statement. "In these situations, the limitation on voting rights reduces the potential that the investor may exercise influence that is controlling."

Finally, the Fed clarified the type of communications a private-equity firm with a minority stake in a bank could have with the institution's management.

"The board believes that a noncontrolling minority investor, like any other shareholder, generally may communicate with banking organization management about, and advocate with banking organization management for changes in, any of the banking organization's policies and operations," according to the policy statement.

"For example, an investor may, directly or through a representative on a banking organization's board of directors, advocate for changes in the banking organization's dividend policy; discuss strategies for raising additional debt or equity financing; argue that the banking organization should enter into or avoid a new business line or divest a material subsidiary; or attempt to convince banking organization management to merge the banking organization with another firm or sell the banking organization to a potential acquirer."

At issue is the Bank Holding Company Act, which requires any investor with a stake in a bank larger than 24.9% to register as a bank holding company and submit to regulation and examination by the Fed.

In an effort to limit control over banks, the Fed also steps up supervision of investors when their stake in a bank exceeds 9.9% by, for instance, limiting their voting rights and the number of seats they hold on bank boards of directors.

Though it would take an act of Congress to raise the standard for bank holding company registration beyond 24.9%, the Fed's move serves to provide more flexibility for investors with holdings higher than 9.9%.

Private Equity Firms Eye Banks as Fed Considers Rules

By Jeannine Aversa, AP Economics Writer
June 27, 2008

The Federal Reserve is looking into making it easier for private equity firms to invest in banks. The move could usher new capital infusions to cash-hungry banks to cope with credit problems.

Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson have been encouraging banks to raise more money to rebuild balance sheets that have been hit by billions of dollars in losses from bad investments in mortgage-backed securities.

A global credit crisis and financial turmoil have made it increasingly difficult for banks, Wall Street firms and other financial institutions to line up capital.

The Fed is considering steps that would help give private equity firms a better understanding of what they can and cannot do as they weigh making an investment in a bank.

"We are looking at ways we can make those things more workable and gain from the experience we've had over the past few years," said Scott Alvarez, the Fed's general counsel.

Private equity firms, which put together massive pools of money to invest, can take stakes in banks now. However, the Fed has gotten a lot more questions from private equity firms and others recently about how large a stake they can take without being subject to regulatory supervision.

Under federal law, an investment of 25% or more in a bank would trigger Fed regulations. In reviewing individual cases, the Fed has generally found that investments of less than 10% don't constitute a "controlling interest" in the bank and thus don't trigger regulatory oversight.

That's left a gray area — the treatment of potential bank investments of more than 10% and less than 25%.

For several years, the Fed's legal staff has been looking into this matter. No decision is imminent, but some clarity could come later this year. It's not known how this might happen, through guidance from the Fed, changes in rules or some other method.

The Fed's possible action was first reported by The Wall Street Journal.

The newspaper said J.C. Flowers, Carlyle Group, Kohlberg Kravis Roberts and Warburg Pincus were among those meeting with Fed officials on the matter.

In an opinion piece Thursday in The Wall Street Journal, Randal Quarles and Olivier Sarkozy, managing directors at the Carlyle Group, made the case for leeway.

"Private equity is ready and willing to step forward in large amounts — restoring lending capacity, encouraging efficiency and protecting the taxpayer," they wrote. "The Federal Reserve and other banking regulators can help remove obstacles to this important pool of capital."

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